“Monetary
policy has less room to maneuver when interest rates are close to zero.”

–
Ben Bernanke

“Many
Americans rely on interest income from their savings to help cover their cost
of living.”

–
John Delaney

When I
was growing up – and until I was well into my 60s, in fact – one of the
fixtures of daytime TV was the soap opera As
the World Turns. It was often the highest rated of the soaps, but I
have to admit that I probably watched it only once or twice. Its stars were the
reality-TV celebrities of their time.

Now,
there is a high probability that you too are a soap opera fan, but a soap in a
different genre, though still brought to you by our beloved mass media…

As the Fed Turns

The
highest-rated soap opera ever, at least among those with an economic and
investment approach to life, is the show put on by the US Federal Reserve. I’m
going to have a few things to say about the recent FOMC meeting, and we’ll use
it as a springboard to chew the fat about the new season and upcoming episodes
of our very own soap opera: As
the Fed Turns. Just as devotees of As the World Turns used to speculate about what
their favorite characters were up to, we can have a little fun opining about
the Fed’s next moves. Now, a Trump presidency offers a lot of potentially juicy
drama, too, and we’ll certainly want to chat about it. And of course, we won’t
be forgetting that this is soap opera with real-world implications for the
markets and our investment portfolios.

Very
few things are certain in financial markets these days. We used to be certain,
for instance, that interest rates would always positive be positive. Now we
know that’s not so! But last week we experienced a moment of near-certainty
when federal funds futures contracts said the odds of an interest rate hike
were 95% or better. That turned out to be true.

What
wasn’t certain was what we would hear in Janet Yellen’s commentary and see in
the projections of the FOMC participants. They gave us some things to talk
about, and they even gave us their dot plots; but there is very little that’s
certain in those. In next season’s Fed, executive produced by Donald Trump, those
dot plots will have even less predictive power than they do now. There are some
obvious reasons why the plots are continually wrong, but they’re about to be
more wrong.

What We Learned from As the Fed Turns This Week:

1.
The Fed thinks GDP growth is stuck in low gear.

2.
They believe the US economy is at or near full employment.

3.
Interest rates will rise but not too much.

4.
They don’t want to think about fiscal policy.

5.
Janet Yellen will stick around through 2017.

6.
And the fun part – speculation about the drama surrounding new appointments to
the FOMC. Will Trump get to appoint just two governors or the full monty of
seven? Both scenarios are possible. As in any soap, you need to have some
uncertainty to keep people off balance and paying attention. Trump’s appointees
will make a difference in policy, but will their policy change the reality on
the ground of the global economy?

I’ll
expand on each of the above points. I was travelling or in meetings most of the
week, so I wasn’t able to tune into this week’s drama as it unfolded. I think
that may be just as well. Initial analyst and public response is often wrong,
but it can “anchor” our thinking in ways that aren’t helpful. Sometimes it’s
better to walk into the room late and then just calmly meditate on what you
see.

Secular Stagnation Forever?

Promoting
economic growth and employment is one of the Fed’s core missions, assigned to
it by Congress in (I believe) 1974. It was a triumph of Keynesian thought over
Hayek’s beliefs; and despite all evidence to the contrary, most market
participants still think that monetary policy is the magic that drives the
business cycle. Policy is supposed to moderate the boom-and-bust cycle and lift
the economy out of recessions within a reasonable period.

On that point,
monetary policy has failed miserably. We’re seven years out of recession and
have yet to see GDP growth break above 3%.

The
Fed’s answer in this week’s episode was to throw in the towel: Expect more of
the same. Here’s actual growth since 2011 and the FOMC’s projections through
2019. Notice that the top end of the range of growth is barely more than 2%.

You
can see that 2013 was a “good” year. Ben Bernanke was confident enough to start
talking about “tapering” down from quantitative easing. Staying on that path
another year or two might have changed everything. But it didn’t. There was a
global taper tantrum; Growth fell back again; and now even the most optimistic
FOMC participants see little chance that it will climb much above 2% through
2019.

(One
caveat – and it’s one that I feel the need to keep repeating: GDP is a deeply
flawed statistical measure that doesn’t fully capture the way today’s economy
works. We use it because we have nothing better.)

Former
Treasury Secretary Larry Summers, who desperately wanted to star in the show
Janet Yellen now headlines, famously called the current trend “secular
stagnation.” He thinks we should all get used to it because its structural
causes are impossible to change. Yellen and her crew might not use language
that strong, but they appear to mostly agree with Larry.

Are
they right? Maybe, but I think we can escape this dreary fate if we play our
cards right.

Jobs, Jobs, Jobs

The
unemployment trend is looking better. The rate has fallen pretty steadily and
is now below 5%. The FOMC expects it to stay there, too.

The
problem is that not all jobs are equal. The wealthy law firm partner and the
student-debt-plagued law degree holder who is instead driving for Uber both
count as “employed,” even though their situations are vastly different.

Also
problematic: The unemployment rate is down in part because so many workers have
left the labor force – or, increasingly, never entered it. My airplane reading
this week included a short, fascinating book called Men
Without Work: America’s Invisible Crisis, by Nicholas
Eberstadt. He documents evidence that this abandonment of the labor force isn’t
a new problem, either. It has been quietly building for decades. It has
multiple causes that aren’t at all easily solved. It is likely that I will
write about this book in at least one or two future letters. Eberstadt’s data
is both compelling and depressing.

Roughly
10 million American males of prime working age have literally dropped out of
the workforce. And we wonder why productivity is low. Again, this problem has
been building steadily since the ’60s. The trend has held steady through boom
periods and recessions, and the Clinton/Gingrich welfare reforms didn’t affect
it. France and Greece have significantly higher labor force participation rates
than the US does. And no, these dropouts are not Trump voters, and it’s not
just the labor force they don’t participate in. This is a major and very
troubling social trend.

However,
let’s not overlook progress we have made. We have indeed seen much improvement
from the Great Recession’s depths. Businesses are expanding and creating new
jobs. The problem is that we have a mismatch between the skills of jobless
people and the kinds of work employers need done. That is not something lower
interest rates can solve.

We Got Dot Plots

Now to
the main course: Dot Plots du Jour. The dots that the FOMC members contribute
to the plot indicate their expectations for the federal funds rate.

By the
way, I saw a tweet this week in which someone said that the dot plots are not
“forecasts.” It’s true that the Fed doesn’t use that word. They call the plot
their “assessment of appropriate monetary policy” for certain points in the
future. So technically, it’s what they think rates should be, not a prediction of what rates will be on those dates.

Is
that a forecast? You can call it whatever you like. I think “forecast” is close
enough.

But
before we look at the whatever-you-call-it, here’s a rate history of the last
16 years:

I’ve
highlighted this fact before, but it’s worth mentioning again: In 2007, less
than a decade ago, the fed funds rate was over 5%. So were the interest rates
for Treasury bills, CDs, and money market funds. People were making 5% on their
money, risk-free. It seems like ancient history now, but that year marked the
end of a halcyon era of ample rates that most of us lived through. The chart
below shows historical certificate of deposit rates – but remember, you could
put your money in a money market fund and do better than the six-month
certificate of deposit yield, back in 2007.

Today’s
young Wall Street hotshots have never seen anything like that. To them the jump
from 0.5% to 0.75% must seem like a big deal. It’s really not. If the chart
above were a heart monitor readout, we would say this patient is now dead and
that last blip was an equipment glitch.

The
point to all this is that these near-zero rates to which we have all adapted
are by no means normal or necessary to sustain a vibrant economy. We’ve done
fine with much higher rates before. They are even beneficial in some ways –
they give savers a return on their cash, for instance. But there are likely to
be consequences once we embark on this rate-increase cycle, and I’ll examine
them later in this letter.

The
FOMC cast members are all old enough to remember those bygone days of higher
rates as well as I do. So we would think they might at least foresee a return
to normalcy at some point in the future. Not so. They see nothing of the sort.

Here
is the official dot plot published by the FOMC. (I have included their
preferred heading so that no one complains about my calling it a forecast, even
though that’s what it is.)

Each
dot represents the forecast assessment of an FOMC member. That group
includes all the Fed governors and the district bank presidents. All 17 of them
submit dots, including the presidents of districts who aren’t in the voting
rotation right now.

There would be 19 dots if the two vacant governor seats had
been filled.

That
flat set of dots under 2016 represents a rare instance of Federal Reserve
unanimity: They all agree where rates are right now. (See, consensus really is
possible.) The disagreement sets in next year. For 2017 there’s one lone dot
above the 2.0% line, but the majority (12 of 17) are below 1.5%.

Nevertheless,
it will be a much different year than this one if they follow through. The dots
imply that the fed funds rate will rise a total 75 basis points next year.

Presumably, that would be three 25 bps moves, but they can split it however
they want. They could ignore their expectations completely, too. This time last
year, the FOMC said to expect a 100 bps rise, or four rate hikes, in 2016. We
got only one.

Follow
the dots on out and you see that their assessments trend a little higher in the
following two years, and then we have the “longer run” beyond 2019. Most FOMC
participants think rates at 3% or less will be appropriate as we enter the
2020s. The most hawkish dot is at 3.75%.

Think
about what this means. Today’s FOMC can imagine raising rates only to the point
they fell to about halfway through their 2007–2008 easing cycle. They see no chance that overnight rates
will reach 5% again. None.

Here
is another view of the same data, courtesy of Business Insider. They added the September dot
plots, so we can see how the dots shifted.

Looking
at each set of red (September) and blue (December) dots, we see only a slightly
more hawkish tilt than we saw three months ago. The “Longer Term” sets are
almost identical – two of the doves moved up from the 2.5% level, while the two
most hawkish hung tight at 3.75% and 3.50%.

That
word hawkish is
relative here. By 2007 standards, these two voters are doves. But, Toto,
I’ve a feeling we aren’t in 2007 anymore.

Trump? Who’s That?

I got
an email from the brilliant Peter Boockvar after the FOMC news. He said, “If
something changed on November 8th, the Fed didn’t see it.” That was
a good way to put it. The same election that jolted markets into some of the
sharpest moves in years barely affected the FOMC participants. That’s very
clear from the near-identical red and blue dots in the chart above. Peter’s
take?

Now
the dots predict 3 in 2017, and the market this time actually believes we may
get it because of Trumponomics and the reality that Fed forecasts must shift
higher.

Three rate hikes, though, will only take us to a whopping fed funds
rate of 1.375%.

Even with a zero rate for 8 straight years, the 25-year average
in the fed funds rate is still about 2.75%. Headline CPI today is expected to
print 1.7%. We should still see negative real interest rates in 2017. The
dollar doesn’t care about the absolute level of rates as it continues to rip on
the continued growing rate differentials. I’m waiting for the Trump tweet
complaining about the strong dollar. I find that to be inevitable if he wants
to bring manufacturing jobs back to the US.

Are
the Fed governors and bank presidents in denial? I don’t think so. Whether they
supported the election outcome or not, they know what happened. They know how
markets reacted. They know a whole bunch of things are about to change. So why
are they so stubbornly sticking to their guns?

This
may surprise some of you, but I’m going to defend the Fed on this point.

I
wholeheartedly believe Donald Trump and the Republican majority will enact a
sweeping package of tax cuts, at least a modest infrastructure spending
program, and hopefully some radical deregulation. It won’t be exactly what any
of us want, but they’ll make some good moves that should help the economy,
which is badly in need of some help. (As we will see below, there are other
forces that are problematic.)

But
here’s the rub. We don’t
yet know exactly what it will all look like. Right now, we’re
hearing a lot of ideas and speculation. Presidents never get everything they
want from Congress. Trump may get more than most, but I doubt he’ll get it all.

Senators and Representatives have their own ideas and incentives. Serious
prognosticators are paying a lot more attention to House Ways and Means
Chairman Kevin Brady than the media is. Brady’s ideas are well-known, but
they’d be a radical departure from current policy. And every economist knows
that any change comes with a time lag before its effects are truly seen in the
economy.

Likewise,
the details matter. Tax reductions are generally good, but they can have more
or less growth impact depending how they are constructed. There’s also the
question of how they will affect the debt. That problem isn’t going away. The
same with spending and deregulation.

There’s
a lot we don’t know, and right now what we do have is mostly guesswork. Do we
really want a Federal Reserve that reacts to guesswork? I don’t. I want them to
look at hard data and make their best judgment calls. This week’s hike was
probably going to happen no matter how the election turned out. They told us in
the dot plot to expect more hikes next year, totaling 0.75%. They have plenty
of time to react to whatever fiscal policy changes make it to the president’s
desk.

The
same applies to their morose GDP projections. Do they think the coming changes
will have no effect? Probably not. But they don’t know exactly what the changes
will be, which makes their impact hard to assess. Plus, while I don’t agree
with Summers on secular stagnation, I do agree that long-term forces are
causing a generally slower growth environment.

We’ll
get a new dot plot at the mid-March FOMC meeting. By then we should have a much
better sense of fiscal policy changes. I suspect the impact will be visible in
that meeting’s projections, and certainly by the meeting in June.

The Great Shake-Up

The
current FOMC may have some new voters by March. There are two vacant seats
Trump can fill as soon as he takes office and gets the Senate to confirm them.
But it appears Janet Yellen isn’t going anywhere. Asked about her own future at
the news conference, she noted that the Senate had confirmed her to a four-year
term as chair and that she plans to finish it on schedule, that is, on February
3, 2018.

And
this is where we get some drama. Trump could have anywhere from a minimum of
two appointments in his first term to possibly all seven. We’ll start with some
facts and then throw in some speculation. I should note that I have talked
about this with a number of people who have deep insights and contacts in the Federal
Reserve, but I owe a special word of thanks to Danielle DiMartino Booth, whose
new book on the Fed will be out on Valentine’s Day. We will preview it here,
and I’m sure it’s something you’ll want to read. It is getting rave reviews
from the coterie of insiders she has allowed to read it. Now to the drama…

At
Yellen’s press conference she made a couple of notable points. She specifically
noted that Federal Reserve appointments aren’t tied to presidential elections.
I think that was a hint that she will defend the Fed’s independence, or at
least try to.

She
also left open the possibility of staying on the Board of Governors even after
her term as chair is over. Those are separate appointments. She can stay on the
board until January 31, 2024. At age 70 now, I doubt she will, but it’s
possible. We know Supreme Court justices delay retirement so that a president
they like can appoint their successor. I think Yellen was reminding Trump that
she has that option.

The
same is true for Vice Chair Stanley Fischer, by the way. His board term lasts
until January 31, 2020, so if he chooses to stay it will be until either
Trump’s second term or someone else’s first .

You
all know that I think the Fed needs a major shake-up. I think Trump can do it,
too, but only to the extent there are vacancies he can fill. There are the two
current openings, but beyond them he will need some of the current five
governors on the FOMC to step down voluntarily. The others’ terms all extend
through 2022 or later.

For
the record, the other three serving Board of Governors members are Daniel
Tarullo, whose term does not end until January 31, 2022; Jerome Powell, whose
term isn’t over until January 31, 2028; and Lael Brainard, whose term ends on
January 31, 2026. They can all elect to stay.

Now, I
am told that Yellen actually wanted to raise rates in September but that she
would have had two dissenting votes from members of the Board of Governors.
It’s one thing to get dissenting votes from the district Federal Reserve
presidents who are serving as voting members on the FOMC; it’s another thing to
get dissenting votes from the members who are appointed to the Board of
Governors. There has not been a dissenting vote from a governor since 1996 –
not to say it couldn’t happen next meeting, but just to give you an idea how
rare it is.

If
Yellen and Fischer decided they wanted to stay and the other three current
board members also agreed to stay on, together with the generally dovish
district Federal Reserve presidents, they could seriously hamstring any real
shift in Federal Reserve policy that Trump might prefer.

That
means the two appointments that he initially makes may be his only true options
to eventually become chairman and vice chairman. While I don’t think this
outcome is likely, is clearly an option in everybody’s back pocket. That
ratchets up the importance of the first two appointments.

Fortunately
for Trump, it’s pretty rare for Fed governors to complete their full 14-year
terms.

First of all, you have to realize that they get something like $169,000
a year. That’s a rounding error in their speaking income, not to mention what
they can get by sitting on major corporate boards and consulting. And
seriously, you have to be a total data wonk to get any excitement out of some
of the responsibilities they have. So consequently, they either retire or seek
other opportunities (and maybe a bit more fun). So there’s a good chance Trump
appointees will hold at least four of the seven Board of Governors seats by the
end of his first term. That could happen as soon as mid-2018 if Yellen and
Fischer retire when their leadership positions end.

Okay,
let’s ratchet up the drama. Lael Brainard was hoping to be appointed Secretary
of the Treasury under a Clinton administration. Clearly, that’s not going to
happen. She’s young enough that a future Democratic president could appoint her
to the position, but does she want to hang around on the Federal Reserve for a
minimum of four more years? I am told she doesn’t.

By
people who know Governor Tarullo (and like him), I am told that he is likely to
leave sooner rather than later. Currently, he is head of the Federal Financial
Institutions Examination Council, a spot he is certainly qualified for but one
that is generally given to the Federal Reserve vice chair. He is 64 years old,
and I don’t think he will want to hang around just holding down a spot.

Jerome
Powell’s background is impressive, but I wonder if he would want to be the
last man standing of the current governors. I have heard nothing either way and
no one seems to really know, other than Governor Powell. He is actually the
lone Republican on the board but has not proven as hawkish as some people
thought he would.

Also
for the record, I know that both John Taylor and Kevin Warsh would like to be
Fed chairman. Either one would be a good chairman, but my true preference would
be Richard Fisher, the former Dallas Federal Reserve president. The coming
times are going to be extremely difficult to navigate by the limited means of
monetary policy, but within that scope, the wisdom and counsel of Richard
Fisher would be a great addition. There are any number of good governor
nominees, but let me put the names of Dr. Lacy Hunt and David Malpass on the
list. Especially Lacy. True aficionados of the genre know that these two are
not always on the same page, but they both bring an enormous amount of
historical knowledge and economic sagacity. We are coming into a world where
there will not be many good choices, and choosing among the – well, let's just
call them less than optimal – choices will demand that wisdom. Just saying…

So
it’s possible that Trump gets at least six and maybe seven appointments within
his first two years to the Board of Governors of the Federal Reserve.

Even
if you like nothing else about Donald Trump, you really should celebrate this
part. The stars
have lined up to give an “outsider” president a shot at completely remaking the
Federal Reserve. Washington is full of agencies that need a shake-up, of
course. I expect many will get one. None need it more than the Fed. In terms of
long-term impact, reshaping the Fed could be one of Trump’s greatest
undertakings.

That
being said, if he gets the number of appointments that I think are likely, that
means he “owns” the Fed, in terms of having to take responsibility for its actions.
It goes back to Colin Powell’s philosophical line, “You break it, you own it.”

The
problem is, as I have been repeating, that monetary policy is unlikely to be
all that effective in the future. It is questionable how effective it has been
in the recent past, aside from driving up asset prices, which hasn’t done much
for Middle America.

I keep
pointing out that we really do have to be paying attention to what is happening
in Italy and Europe, too. Italy is truly on the brink of a major crisis. Maybe
I should write that as MAJOR
CRISIS. One that can send Europe into a deep recession and
push the world to a global recession.

Let’s
review the reality on the ground. In a conversation I had yesterday with Dr.
Lacy Hunt, he pointed out that total US debt is $70 trillion. $20 trillion of
that will have its interest rates reset within the next two years. That means a
minimum of $200 billion more interest, which comes directly out of the
productive economy. Now, that money is partially transferred here or there, but
it is clearly not stimulus. As I have demonstrated in past letters, at some
point debt becomes a drag on the economy, and we are at that point.

Further,
and without getting too deep into the weeds, the QCEW (an employment report)
suggests that the actual number of added jobs in the US may be overstated by
190,000 or more and will get adjusted next year when we get the normal
revisions. And as I mentioned, 10 million American males are no longer in the
labor force and aren’t looking for work. No productivity or any other help for
the economy there.

The
bulk of the current FOMC members believe that GDP growth will remain below 2%.

There is reason to think that 1.5% is closer to the real potential. For all
intents and purposes, that’s stall speed. A crisis in Europe, and President
Trump has a recession on his hands. And as I have consistently pointed out for
20 years, presidents have *&^%&^% little control over the economy – but
they get blamed or praised, take credit or point fingers, for whatever happens.

Whatever
happens, it is going to be an interesting next four years. Let me make a
personal admission. This will probably earn me no kudos from anyone, but in my
private moments over the summer and going into the election, I consoled my
friends with the possibility that while Republicans might lose at the ballot
box, the fact that the likelihood of a recession in the next four years was so
high that a Clinton presidency and progressives in general would be blamed for
it. Blamed unfairly, at least to some degree, although they are responsible for
the regulatory environment we live in today. But this would lead to a massive
sweep in 2018 and 2020 and in the long view might change things for the
following 10 to 15 years.

Now?
Republicans own it. At least in the minds of the voters. And for the record,
let me clearly state that the policies that I expect a Republican president and
Congress to initiate will go a long way to mitigating the negative effects of a
recession, far more than the dovish and more repressive regulatory and high-tax
policies of a Clinton administration would have done. But arguing that things
are at least better than they would have been does not make for a very good
political campaign slogan.

To an
agonizingly great degree, the incoming US administration is hostage to the
German election cycle, which means that Merkel cannot condone bailing out
Italian banks until after her election in the fourth quarter of next year.
Sometimes, bond markets can be very inconvenient. Italy is in extremely deep
kimchee. And that’s putting it delicately. Unlike Greece, Italy matters. Italy
is too big to bail out, too big to save. A breakup of the euro practically
guarantees a deep recession in Germany – and I mean really deep. Which will
suck in its other northern partners. A recession in Europe would drag the world
down – including a debt-driven China.

You
want soap opera? What happens when the currencies of the world start falling
significantly against the dollar? Currency manipulation or the real world? What
does a Trump Treasury Department do in response? Labeling everybody as currency
manipulators won’t work very well. Punitive tariffs are counterproductive. Do
we actually respond by monetizing the federal debt (at least the debt held in
the US) in order to reduce the value of the dollar and keep from completely
devastating the potential positive aspects of a new corporate income tax
policy? That would not be an irrational response, as it would essentially be what
the rest of the developed world was doing.

Dear
gods, we are moving into a world where we have absolutely no idea how things
are going to unfold. The uncertainty gage is pegging into the far-right red
zone.

There
are so many moving parts to the puzzle that it is hard to keep track of them. I
am going to get on a plane tomorrow to go meet in NYC with some of the
“insider” economists and thought leaders of the upcoming administration. And
I’m going to pose those very questions to them. For the most part, they are
friends or at least acquaintances. And in their private moments, they show me
that they “get it.” I will readily admit to being the Debbie Downer in the
group.

“The
problems of victory are more agreeable than the problems the defeat. But they
are no less difficult.”

New York (again), Florida, DC, and the
Caymans

As
noted above, I’m on my way to New York City on Monday and then hope to be back
home for the holidays. There will be no letter on Christmas weekend. I’m still
thinking about what to do over the New Year’s weekend, but my annual forecast
letter will come out the following week.

After
that, I’ll be at the Inside
ETFs Conference in Hollywood, Florida, January 22–25. If you are in
the industry and coming to that conference, make a point to meet with me. I
will be making some big announcements at the conference. Then I'll be at
the Orlando
Money Show February 8–11 at the Omni in Orlando. Registration is free.
There is also the high probability that I will be in Washington DC during the
inauguration as one of the corporate boards I am on is probably going to shift
their meeting to coincide with the inauguration. And I am
tentatively scheduled for a conference in the Cayman Islands.

Let me
wish you a sincere Merry Christmas and/or Happy Holidays. Most of the Mauldin
clan will be gathering for Christmas, and I am looking forward to it. Some of
them are dragging me, albeit not totally unwillingly, to Rogue One tonight. While I
have seen all the Star Wars movies, they are starting to become redundant,
derivative science fiction storytelling that doesn’t acknowledge the real
possibilities of a resplendent technological future. I was actually going to
skip this one, but I am being pulled along by some of the younger members of
the clan. I can’t gripe, because at least it’s not a chick flick.

For
me, the time between Christmas and New Year’s is when I think about the future,
and for the last 50+ years it is always the most optimistic week of my life.
Debbie Downer leaves the room and Pollyanna John emerges. The sun will come out
tomorrow, etc. That attitude is not always reflected in my annual forecasts,
but more often than not they have been pretty positive. But then again, I am
often wrong but seldom in doubt, so you need to bear that in mind. In any case,
I (probably foolishly) persevere in the annual predictive ritual.

SINGAPORE – The big question in Asian countries right now is what lesson to take from Donald Trump’s victory in the United States’ presidential election, and from the United Kingdom’s Brexit referendum, in which British voters opted to leave the European Union. Unfortunately, the focus is not where it should be: geopolitical change.

Instead, for the most part, economic narratives have prevailed: globalization, while improving overall wellbeing, also dislocates workers and industries, and generates greater income disparity, creating the anxious electorates that backed Brexit and Trump. An alternative narrative asserts that technological advances, more than globalization, have exacerbated economic inequalities, setting the stage for political disruptions in developed countries.

In either case, policymakers in emerging countries have identified inequality as a major problem, and rallied around efforts to improve social mobility, lest globalization and new technologies displace their middle and working classes, and clear a path for their own versions of Trump and Brexit. For Asian countries, the policy prescription is clear: take care of disadvantaged populations and provide retraining and new employment opportunities for displaced workers.

Of course, all societies should look out for their poorest members and maximize social mobility, while also rewarding entrepreneurship and challenging people to improve their lot. But focusing on such policies would not address the public disaffection underlying the populist uprising, because inequality is not its root cause. Feelings of lost control are.

Even if countries closed their domestic income and wealth gaps and ensured social mobility for all their citizens, the forces fueling public dissatisfaction around the world today would remain.

Consider the US, where the inequality narrative’s poster child has become the displaced, older, less-educated, white working-class male. Many people credit these voters for Trump’s victory, but the poster-child cohort did not actually have the biggest impact on the election outcome.

According to exit polls, Trump won 53% of white male college graduates, and 52% of white women (only 43% of the latter group supported Clinton); he won 47% of white Americans between the ages of 18 and 29, compared to 43% for Clinton; and he beat Clinton by 48% to 45% among white college graduates overall. These Trump supporters do not fit the stereotype at the center of the economic narrative.

Meanwhile, more than half of the 36% of Americans who earn less than $50,000 annually voted for Clinton, and of the remaining 64% of voters, 49% and 47% chose Trump and Clinton, respectively.

Thus, the poor were more favorable toward Clinton, and the rich toward Trump. Contrary to the popular narrative, Trump does not owe his victory to people who are most anxious about falling off the economic ladder.

A similar story unfolded in the UK’s Brexit vote, where the “Leave” campaign asserted that the EU’s supposedly burdensome regulations and exorbitant membership fees are holding back the British economy. This hardly amounts to an agenda to fight economic inequality and exclusion, and it is revealing that rich businessmen wrote the largest checks to support Leave.

Moreover, the street-level emotions that contributed to Leave’s victory were not rooted in income inequality or “the 1%”: alienated poor voters directed their anger at other alienated poor people – particularly immigrants – not at the rich. The Mayor of London’s office reported a 64% increase in hate crimes in the six weeks after the referendum, compared to the six weeks before it. So, while income equality may have been a part of the Brexit campaign’s background noise, it was not the first issue on Leave voters’ minds.

What unites Trump and Leave supporters is not anger at being excluded from the benefits of globalization, but rather a shared sense of unease that they no longer control their own destinies. Widening income inequality can add to this distress, but so can other factors, which explains why people at all levels of the income distribution are experiencing anxiety. Indeed, many people in Eastern Europe felt a sense of lost control during the harsh socialist experiments of the post-war era, as did many Chinese during the Cultural Revolution, and these societies had minimal visible income inequality.

Paradoxically, Brexit and Trump supporters might be feeling the effects of globalization because overall inequality has actually declined. Globalization’s largest effect has been to lift hundreds of millions of people in emerging economies out of poverty. Throughout the 1990s, emerging countries’ combined GDP (at market exchange rates) amounted to barely one-third of the G7 countries’ combined GDP. By 2016, that gap had essentially vanished.

.

.Low international income inequality, rather than growing income inequality in individual countries, is putting unprecedented stress on the global order. There is a growing mismatch between what Western countries can provide, and what emerging economies are demanding.

The power of the transatlantic axis that used to run the world is slipping away, and the sense of losing control is being felt by these countries’ political elites and ordinary citizens alike.

Trump and the Leave campaign appealed to voters by raising the possibility that transatlantic powers can reassert control in a quickly changing world order. But with the geopolitical rise of emerging economies, especially in Asia, that order will have to achieve a new equilibrium, or global instability will persist. Closing the income gap can help the poor; but, in the developed countries, it will not alleviate their anxiety.

IN A YouTube video released on November 22nd, Donald Trump—seated in front of an American flag and a leonine statue—confirmed his plan to put America first, “whether it’s producing steel, building cars or curing disease”. Mr Trump has already arm-twisted Carrier, a maker of airconditioning units in Indiana, to keep 800 jobs in the state rather than move them to Mexico. His transition team is preparing a list of “executive actions we can take on day one to restore our laws and bring back our jobs”. Implicit in the video was Mr Trump’s view of international trade: a patriotic contest in which countries strive to take each other’s jobs—or seize them back. In Mr Trump’s view of the world, trade deals are adversarial and zero-sum. Other countries are rivals competing for the same spoils, not trading partners enjoying mutually beneficial exchange. His plans to scupper the Trans-Pacific Partnership (TPP), a deal painstakingly negotiated over ten years with 11 other countries around the Pacific Rim, tally with Mr Trump’s reading of history. Too often, he thinks, bad deals, like the North American Free-Trade Agreement (NAFTA) and China’s accession to the World Trade Organisation (WTO), have destroyed American jobs and created American losers..

For Mr Trump, evidence of this pilfering lies in America’s trade deficit, which is most dramatic for goods (see chart 1). “China is both the biggest trade cheater in the world and [the] country with which the US runs its largest trade deficit,” wrote Wilbur Ross, Mr Trump’s pick as commerce secretary, and Peter Navarro, a senior adviser to his campaign, in September in a description of the next president’s economic plan. Mr Ross has said he wants to “spread the trade-deficit issue around the globe”.The trade misery that Mr Trump laments is recognisable to Nate LaMar, a sales manager at Draper Inc, which makes window shades, projector screens and gym equipment. He remembers his home state of Indiana being hit hard by job losses as the car and steel industries collapsed 15-20 years ago. Even in his own company, it “felt like we were floating down a river towards a waterfall”. Chinese competition encroached on their export orders first, and then their domestic customers, flooding the bottom end of the market with cheap imports.No one knows exactly what President Trump’s trade policy will look like—perhaps not even Mr Trump himself. His alarm about foreign competition, and his suspicion of trade deals, runs deep in his rhetoric, permeating his stump speeches. But even many of his supporters hope that he will stop short of some of his more radical campaign pledges. Mr LaMar is one of them. “I’m hoping cooler heads will prevail,” he says, naming Mike Pence, the vice-president-elect and a free-trade advocate.Many of Mr Trump’s picks suggest radicalism, however. According to a transition-team press release, Mr Trump’s cabinet choices “signal a seismic and transformative shift in trade policy”. His personnel hint at an aggressive stance against Chinese steel in particular. The transition team includes Dan DiMicco, former boss of Nucor Steel, and Robert Lighthizer, a trade lawyer who has built a career arguing for higher steel tariffs, and is known in trade-policy circles as “the most protectionist guy in Washington”..

If hotter heads do win out, how far might Mr Trump go? Protectionism around the world is creeping up (see chart 2 ). But if Mr Trump follows through on his promises, that trend will be turbocharged. He has threatened to withdraw from NAFTA (“the worst trade deal maybe ever signed anywhere”, he insists). On December 4th he tweeted that there would be a tax of 35% on firms that fired employees, built a factory in another country and then tried to sell their products back across the border. He plans to label China as a currency manipulator on his first day in office and has threatened tariffs of 45% on its products.Many foreigners blithely assume that America’s system of checks and balances will stymie Mr Trump’s more radical tendencies. But for trade, those checks and balances are weak. The president would have huge power to carry out his threats, at least in the short term. Under the Trade Act of 1974 he could impose quotas or a tariff of up to 15% for up to 150 days against countries with large balance-of-payments surpluses (which modern courts would probably interpret as the current-account surplus). And if Mr Trump were to declare a state of national emergency, the scope of his presidential power would extend to all forms of international trade.

Never settle

Mr Trump’s actions could eventually be challenged in American courts. Plaintiffs might claim that he was violating constitutional freedoms or defying the original intention of the laws he would invoke. But Mr Trump may have the legal upper hand. American courts may not intervene to stop a trade war. America’s multilateral trade agreements are also more fragile than they appear. To renegotiate NAFTA, Mr Trump would require approval from Congress. To withdraw from it altogether, he would simply have to give the other partners six months’ notice.

After America’s formal departure, its NAFTA commitments would live on, enshrined in the domestic legislation that implemented them. But those commitments need not restrain a determined president. After merely “consulting” Congress, he could abandon NAFTA’s (mostly) zero duties and instead impose the WTO’s “most favoured nation” tariff rates on Mexican imports, according to Gary Hufbauer of the Peterson Institute for International Economics, a think-tank. For clothing and footwear, these tariffs are high. But on average, they are low: only 3.5%—not very satisfying for a budding trade warrior. He could avail himself of much tougher tariffs by accusing Mexico (or indeed China) of various kinds of cheating: such as subsidising their exports illegally or dumping products on the American markets below cost. Mexico or China could appeal to the WTO, but that would take time. The WTO’s dispute-settlement mechanism is weighed down by a backlog of cases.

If Mr Trump did impose tariffs of 35-45%, the Mexican and Chinese governments would not wait for the WTO’s courts to intervene. They would retaliate. China could cancel contracts with the likes of Boeing, an American plane manufacturer, or disrupt Apple’s supply chain. China is a big customer for some American products. It accounted for roughly 60% of America’s soyabean exports between 2013 and 2015. In a trade war, it could cut these purchases.

After economists at the Peterson Institute highlighted this possibility, team Trump dismissed the analysis as “project fear”. “If China cuts off American farmers, Chinese people will go hungry,” they scoffed. But other countries, such as Argentina or Brazil, produce soyabeans. Switching could be relatively straightforward.

As well as blocking American goods at its borders, China could squeeze the many American firms operating within them. General Motors and its affiliates, for example, sold 372,000 cars in China in November, compared with just 253,000 in its domestic market. In Mr Trump’s own words: “leverage: don’t make deals without it.”

Imposing a punitive tariff on American firms operating in Mexico would be even more disruptive. Under NAFTA, companies have sprawled across the border. “We make things together in North America,” says John Weekes, Canada’s original NAFTA negotiator. Every dollar of Mexican exports to America contains around 40 cents of American output embedded within it. Tariffs of the level that Mr Trump suggests would be so disruptive that Luis de la Calle, a Mexican economist, doubts that they are credible. When it comes to car production, “you cannot run a plant in Michigan without Mexican imports,” he says.

If Mr Trump were to press ahead with his tariffs, the Mexican authorities would first try to find a smart response. They have had some practice. After years of the Americans failing to allow Mexican lorries to cross the border as easily as NAFTA stipulated, in 2009 the Mexicans imposed duties on, among other things, Christmas trees from Oregon. Not coincidentally, the state’s congressional delegation includes a member of the transportation committee. But in an escalating trade war it would be hard to pick a duty that would not backfire. If Mexico stopped importing American car parts, for example, it would hurt its own assembly lines. Retaliation might take unconventional forms. Turning a blind eye to outgoing migrants could rile Mr Trump more than duties on American goods.

Most tariffs backfire, hurting the country that imposes them by raising prices, blunting competition and depriving consumers of choice. In September the Peterson Institute predicted that a symmetric trade war, in which Mexican and Chinese imposed equal tariffs on American exports as America did on their exports, would ripple through the American economy, lowering private-sector employment by nearly 4.8m, or more than 4% by 2019.

Despite domestic and international restraints, Mr Trump would, then, be fully able to start a ruinous trade war. But would he be willing to do so? It could be that his threats to tear up trade agreements and raise tariffs are simply bargaining chips, designed to force governments to the negotiating table. In his book, “The Art of the Deal”, Mr Trump explained that his style of dealmaking is quite simple. “I aim very high, and then I just keep pushing and pushing and pushing to get what I’m after.”

Volunteer, or else

What, then, is he after? In his approach to trade dealmaking, Mr Trump might take inspiration from history. When Ronald Reagan was faced with a big trade deficit with Japan, he browbeat Japan’s carmakers (among others) into restraining their exports “voluntarily”. But life was simpler under Reagan. He could negotiate with a handful of Japanese firms that made their goods in Japan and sold them in America. Today, parts and components criss-cross borders and a great deal of trade happens within firms. “The information you need to have to be able to act strategically seems to me to be daunting,” says Chad Bown, a trade expert. Reagan’s tactics also had unintended consequences. With only a fixed number of cars to sell, Japanese producers innovated and moved into more profitable higher-end products.Mr Trump is keen to increase exports and not just block imports. Indeed, his team may see the threat of import tariffs as a means to prise open foreign markets. Mr Ross believes that China, Japan and Germany should import more liquefied natural gas from America, rather than the Gulf. He also believes that China should relax its import quotas for cotton (although why China would add more imports to its mountain of surplus cotton is not clear).The Trump team’s approach also seems distinctively granular, hands-on and micro-managerial. They are happy to pursue specific commercial outcomes, rather than creating fruitful commercial frameworks. Instead of writing the rules of the game, within which companies are free to make choices, they seem keen to negotiate the outcome of the game: additional cotton exports to China, greater LNG sales to Japan, more Carrier jobs in Indiana...

In their view, the success of these deals is measured by the trade balance that results. Trade deficits are intrinsically bad, they seem to think—a sign the country is losing. Part of the issue is the way trade figures are calculated. Mr Trump is right to point out that Chinese exports account for a large and rising share of America’s total trade deficit in goods. But China’s status as the world’s factory means that much of the value embedded in those exports is in fact coming from America itself. An iPhone shipped from China to America contributes to the Chinese trade surplus, but also Apple shareholders’ bank balances. According to Deutsche Bank, on a value-added basis, China accounts for only around 16.4% of America’s trade deficit in goods (see chart 3).Whether trade deficits are good or bad, trade deals are best seen as a way of raising trade flows in both directions, rather than an instrument for turning deficits into surpluses. According to mainstream economics, a country’s overall balance of trade is more powerfully influenced by macroeconomic forces, such as the strength of demand and the currency. Targeting a bilateral deficit using bilateral tariffs is “a terrible idea”, says Douglas Irwin, author of “Free Trade Under Fire”. But more targeted options exist. A tough stance on Chinese steel is more justifiable than a general crackdown on imports, for example. “It’s crystal clear that China is subsidising their steel industry,” says Mr Irwin...

The Obama administration has already been cracking down: between 2013 and 2015 it initiated 74 anti-dumping investigations into metal products from a variety of countries. On November 7th it found China guilty of dumping certain types of plate steel at more than 68% below cost. On December 11th tension could increase further, as on that day China will claim that their transition to a “market economy” will be complete under WTO rules, reducing their exposure to anti-dumping duties. These investigations are already having a chilling effect on steel imports from China (see chart 4), which fell by 70% in the first half of 2016, compared with a year earlier. Mr Trump may even find himself behind the curve—or claim the credit.There are some sensible things Mr Trump could do. If his team did want to boost American exports, he could lift some ideas from the US Trade Representative’s annual document outlining barriers around the world. He could focus on lowering barriers to American exports of raw milk to Mexico and chicken to China, both of which have imposed health-related import restrictions. On services, where America boasts a trade surplus, a deal to tackle burdensome licensing and discriminatory regulatory process could boost exports.In theory, renegotiating NAFTA would also be no bad thing. The Mexicans would welcome new rules on logistics and e-commerce, which did not exist when NAFTA was first negotiated. Although he cautions that any renegotiation would take time, Mr Weekes says that the evolution of global supply chains warrants an update to the agreement’s rules-of-origin regulations.Mr LaMar would certainly prefer a more constructive approach. His job, after all, is to sell his firm’s products around the world. Those small and medium-sized firms that survived the onslaught of Chinese competition did so by diversifying and expanding abroad. He can take comfort from the words of Robert Zoellick, an American trade negotiator under George W. Bush. “Unusually for a US president, Trump’s words may or may not convey policy. We’ll have to watch what he does, not what he says.”

The incoming Trump administration has made job creation a national priority. But here is a sobering prediction: No matter which political party holds the White House or Congress, over the next 25 years, 47% of jobs will likely be eliminated by technology and globalization, according to WorkingNation. It’s a phenomenon called “structural unemployment” and it affects nearly all industries and even white-collar workers. Venture capitalist Art Bilger founded WorkingNation to sound the alarm about the coming crisis and to spark discussions about potential solutions.Bilger believes the nature of employment is fundamentally changing and cannot be reversed. But workers, businesses and the government can prepare for it if they work together — starting with stepped up infrastructure spending that has bipartisan support. He recently joined the Knowledge@Wharton Show, which airs on Sirius XM channel 111, to discuss his prescription for ameliorating the coming jobs crisis, and what his organization and others have tried so far. (Listen to the podcast at the top of this page.)

An edited transcript of the conversation follows.

Knowledge@Wharton: Your organization did a report on the state of the job market prior to the election. What are some of the necessary things that the next president, his cabinet and the Congress need to address?Art Bilger: You’ve got to start by understanding what the circumstances are out there, because in my three-year journey, it has been quite amazing to [see how little of the crisis is perceived by] even by the most sophisticated people. I have laid [the problem] out to major news executives, foundations, corporate executives — and people haven’t really understood the magnitude of this and how quickly things are changing.[The idea] came to me three years ago at a dinner in New York … and the guest speaker was Larry Summers. … When he opened it to questions, I said, “Dr. Summers, as an economist, a former Secretary of the Treasury and as an educator, can you explain to the audience here how the most advanced economic society on the planet will continue to thrive and possibly even survive with a 30% dropout rate from high school?”I said, “We’re talking about a third of the population that doesn’t have the skills for the jobs of today, let alone the jobs of 10, 20, 30 years from now.” And then, I said, “And to compound it, we’re doing something extremely well, putting aside cost, and that’s longevity.” So I said, “Here’s the math: A third of the population drops out at 15 and we keep them alive to 85. What do you do?”I won’t go into the details of all the back and forth, but the reason I am sitting here now is that when he left the stage, I got up and went to the men’s room, and a guy in the audience chased me down, and when I came out, another guy chased me down. Two more came to my table that night, each of them saying, “I’ve never thought about this.” And I said, “If these major investors and top corporate executives in New York don’t understand this, then the average American doesn’t.” And I have been on this journey ever since.Knowledge@Wharton: Maybe it’s just the culture or where people are in their particular careers, or where a company is in its life cycle, but it doesn’t even occur to them that this is an issue.Bilger: When I posed the question, I narrowed it down to basically just education and longevity. But then you add to that [the impact of] globalization. Put a billion people into the global workforce at lower price points than we work for here. Great for the globe, not so good for jobs here. … So, when you take globalization, technology, longevity and broken education, put those four together, … the slope of the curve [based on the] change in jobs and skills measured against time has never been as steep as it is today. Matter of fact, we don’t even understand how steep it really is. And that’s the issue.

Knowledge@Wharton: In order to be able to tackle that steep curve, the solution can’t just come from corporate America. It has to come from a variety of different sources, right?Bilger: Yes, but first of all, you have to recognize it, you’ve got to create the awareness. After that, then our philosophy is that the solutions are local. It’s not to say that federal tax policy and budget policy can’t influence matters, but the solutions themselves will be created by corporations, by not-for-profits, by academic entities, by local government. There are entities out there that are really doing very interesting stuff, but it has little to no visibility. A key part of what we’re trying to do is create awareness through storytelling.… As we’ve watched [presidential candidates] Donald Trump and Bernie Sanders build their movements over the last year and a half, they made the point that we don’t have to look to tomorrow [for employment disruption]. It’s here today. Donald Trump’s election, which I believe was very much facilitated by the pain and discomfort at local levels, [was] about economics and Jobs.Knowledge@Wharton: Are you optimistic that this is an issue that will be addressed in the near term?Bilger: I believe there will be tremendous action that will take place. [The Trump and Sanders movements that tapped into job insecurity fears have] made my job of creating awareness much easier. Now, the key is [collaboration among] corporations, nonprofits, academics and local government to better understand and accelerate a lot of the programs they’re already thinking about. There are federal policies that can influence it. … Listen, the whole infrastructure job discussion that they’re talking about now is one of the stories that we were actually going to tell.Knowledge@Wharton: How significant will be the jobs crisis?Bilger: A study out of Oxford shows that we could lose 47% of all our jobs within 25 years … through a combination of globalization, automation and the fact that so many people don’t have the skills that will be required for those jobs. There are many corporations out there today who will tell you they have plenty of jobs they can’t fill. They are developing apprenticeship programs, things like that, to re-skill the workforce.Knowledge@Wharton: It sounds like correcting this will take two phases: corporate retraining and the educational system.Bilger: You’ve got two levels here. The first is the typical thing that we talk about, and that is K through 12, community college, four-year college. … There’s clearly a lot that we still should be doing, changes we ought to be making [as we recognize] how jobs will be changing. It doesn’t mean that you can’t go get a liberal arts education, but even here, are there new additions to the curriculum that are a little career-oriented or skills-oriented?The other area that we really haven’t talked about — and it’s one of the key areas I’m focused on — is that we’re going to have to re-skill the 48-year-olds in this country. We haven’t had to do that in this type of magnitude — it’s still called education — but it’s a whole other thing that we really haven’t had to do. But now, projects are being developed for that.Knowledge@Wharton: I’ve heard from some people that it may be harder to do. Some corporations would rather choose to not reinvest in the 48-year-olds; they would rather go with the 22- and 23-year-olds. And that 40- or 50-something generation just gets kicked to the curb.Bilger: There’s a risk of that. One of the issues in re-skilling a somewhat older workforce is, are they going to be prepared? Individually, even if the corporations want to do it, will they be prepared to be re-educated?We’re running some small projects, and we’re already seeing the resistance level of those 48-year-olds to the concept of going back into a classroom. Now, I think there’s some pretty interesting areas that I’m focused on. The whole area of augmented reality for training and education purposes, I think, is pretty interesting. We’re exploring that, and I’d love to be able to tell that story. We’re not there yet.But you know, that’s an example of how you can train that older workforce without having to sit them down in front of a blackboard or a whiteboard and redo a lot of it. The other thing is setting up internships and apprenticeship-type programs inside corporations.We’ve been speaking with Siemens Corp. I heard the CEO speaking one day at a conference, and he was talking about the inability to fill a lot of jobs here in the U.S. What they have done — and I think they started a little over a year ago — is they brought an apprenticeship-type program like the company has in Germany to the U.S. because of an absolute need to bring skills.Knowledge@Wharton: You mentioned autonomous vehicles and autonomous technology in general. That’s going to change the job market. For example, Budweiser made a delivery with an autonomous truck in Colorado. I mean, just the trucking industry alone is one that could see massive change in terms of its labor force in the next decade or two.Bilger: People who drive for a living, whether it’s trucks, taxis, buses, whatever, [will be affected]. In some states, it’s one of the largest [sources of] jobs. … You are talking about a dramatic change in employment in this country. And that’s a key reason that I am doing this, because another thing that’s different is that this time, it’s about the heart of America. It’s not just about the bottom 20%. This is about the lower-middle class, the middle-middle class, the upper-middle class.When the movie “Waiting for Superman” was made, the people on Park Avenue in New York thought it was a terrific movie, but someone else’s issue. What I’m talking about here is, this is about the children and the grandchildren of the people on Park Avenue. It will affect them directly in terms of their own jobs.A Wall Street Journal article published about a year ago [talked about] the whole area of data and analytics. Your marketing department of 10 becomes a marketing department of two, and you get better answers. Well, guess what? Those were good jobs.What would our society be like with 25%, 30% or 35% unemployment? … I don’t know how you afford that, but even if you could afford it, there’s still the question of, what do people do with themselves? Having a purpose in life is, I think, an important piece of the stability of a society.

If you know the other and know yourself, you need not fear the result of a hundred battles.

Sun Tzu

We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.